How litigation financing works as an alternate investment

Litigation financing has only recently been made available to retail investors in India by a tech startup LegalPay through two methods–interim financing under Insolvency and Bankruptcy Code (IBC) and litigation funding.

Interim finance under IBC is a short-term loan given to a company going through insolvency to support them with capital to remain operational while undergoing the Corporate Insolvency Resolution Process (CIRP). “We provide working capital to the company to tide through the governance process (CIRP),” said Kundan Shahi, founder and CEO, LegalPay.

Shahi said repayment under interim financing is given super priority under IBC. “When it comes to repayment, once the company comes back to health, lenders under interim finance are given priority over banks or other lenders from whom the company had borrowed before insolvency.” To guarantee repayment, only those companies are funded who either have substantial assets for liquidation or those who stand a chance to get acquired or be restructured.

“The loan tenure is of 12-18 months and investors can earn 18-25% (pre-tax) interest on their investment,” said Kashish Grover, chief investment officer, LegalPay.

The second option of litigation funding is far more riskier, but can also deliver superior returns. Under this, capital, raised from a consortium of investors, is given to a plaintiff under the agreement that a portion of the legal settlement will be paid back if the case is won.

LegalPay has a team of legal experts who shortlist cases for financing basis their chances of winning. The raised capital is deployed to these shortlisted cases.

Take note that since it’s a non-recourse investment, the firm, and in turn investors, get nothing if the case is lost.

“We spread the capital across several cases to diversify risk. Globally the success rate is around 90% and we have kept a modest expectation of 50% success rate,” said Shahi.

It should be noted that the company signs a non-disclosure agreement with plaintiffs, hence investors are given no information about the cases being funded. “Investors have to trust our underwriting that we’ve assorted a basket of cases for them that holds a high probability of winning. Also, we only look at commercial cases as they have shorter timelines,” said Shahi.

Payouts under this product come as and when cases are won. Earnings are in the form of success cut, which are agreed upon with the plaintiff in advance and may vary across cases. Investors can expect to earn between 2x and 4x on the total principal, said Shahi.

Gains from this product are taxed as profit from business or profession. Investors should note that this is a nascent investment avenue as yet untested over the long term in India and hence carries a high level of risk.